Hurricane Damage Impacts Oil Price

An insightful report in the Financial Times ascribes the recent rise in oil prices above $100 to the far greater than expected losses of oil production in the Gulf from hurricane damage.  As the report also mentions, oil prices have risen despite softness in the global economy.  There are many factors influencing the global price of oil, but considering only the hurricane-induced supply decline and the economy-induced demand decline would lead one to expect lower oil prices ahead as the impacts of the hurricanes recede while the impacts of the recession increases.

The hurricanes’ impacts were primarily to reduce refinery output which has resulted in severe gasoline shortages in some markets.  But the less publicized impact has been to take over 500 kb/d of oil production in the Gulf off line as of Thursday.  Cumulatively, 30.3 million barrels have been taken off the market by the hurricanes. “Nauman Barakat, of Macquarie Futures in New York, said the statistics showed that, in spite of reports that Gustav and Ike had caused no damage, “their impact has been devastating if not more”.”

Economic weakness stems from the global credit crunch, the global real estate recession and the global meltdown in stock prices.  Even real estate in the booming Dubai market is starting to feel  pressure from falling prices elsewhere.  Japanese car companies are making plans to cope with very soft car sales globally.  As I discussed briefly Thursday, car sales, particularly in the developed world where buying a car is often a discretionary purchase, will be severely limited during the next 2 - 5 years as people increasingly come to understand that motor technologies are morphing from the standard ICE (internal combustion engine) to a plug-hybrid electric technology. 

An example of the public’s increased awareness was Chysler’s (DCX) surprising announcement earlier this week that they will soon offer five different EV and PHEV model cars soon.   As consumers come to expect a new motor technology they will be increasingly reluctant to buy a new car that comes with the old technology.   Since it will take many years for car makers to eliminate the glitches from the new engines and ramp up production, there will not be enough of the new cars available for a number of years to satisfy even a relatively small demand.

In fact, that outlook could be optimistic unless car makers are able to solve the battery cost problem that so far is not a done deal.  The lithium-ion battery that Chysler, GM (GM) , Nissan (NIS), and others are planning to use for their PHEV’s is not yet available at a cost that is comparable with the current motor technology or even only slightly higher.   Rather, the new engines might add as much as $10,000 to the cost of a car using today’s available batteries.  The new cars might not fly off the lots at those prices.   If that happened, car sales could be hampered for an even longer time as consumers avoid the old technologies but are unwilling to pay the cost of the new ones.  

The main significance of the car sales problem in regard to the foreseeable price of oil is that it will contribute toward a weak economy for some time, and particularly during the next two years.  That weakness will be increasingly felt over the next year.  The gulf oil production problem, on the other hand, will mostly be solved in the short term - perhaps the next 60 days.  Therefore, other things equal (which they never are) one might expect fairly restrained oil prices for a while.

Comments

[NOWHEREMAN:]

It is inevitable but the inevitable is clouded by perception which currently is pessimistic.

IMHO, I would hold onto hard assets especially oil related but outside of the US. But I do expect oil to retrace to the $90 area at least tempoprarily, Bear markets are known to "Take no Prisoners" so that everything can be impacted regardless of value.

My suggestion in such a market is to hang in there if you are getting well paid(CanRoys and other Oil related trusts like TNK) and putting in buy stops way below the market on oil stocks which you missed on the way up because you now have the hindsight of their intrinsic value which will eventually attract other buyers.

2008 Sep 29 09:19 AM

[yank:]

Jim:
Trust me on this. No one either in developing or developed markets is going to hang around and wait for a plug-in technology car. Especially one that is thousands more than the ICE one. We have already seen that the "economics" of a hybrid (yrs to pay off the added cost) only make sense if you drive over 50,000 miles per year or keep the car for more than 150k miles. How many people do that? Answer: Not many.
Using myself as an example just last month I went out and replaced my chevy Suburban with a Kia Optima. I just swapped 15 mpg for 28 mpg and paid the same price for the new KIa as the Suburban was used. People will not wait around for a technology that may or may not be a substantial improvement over the ICE.

Regards,
Yank

2008 Sep 29 10:02 AM

[Jim Kingsdale:]

Yank - you make a valid point if oil stays around the current price. But if oil goes back to making new highs as I expect it will within a year to 18 months then people will look for that 100+ mpg car, not the 28 mpg improvement, imho. Jim

2008 Sep 29 10:53 AM

[isaac the t...:]

Heres a thought chain-
The rise in oil prices this past year was, in effect, a big tax on individuals and companies. This massive oil bill contributed to putting the fragile credit/financial system here in the US over the edge, by bringing a halt to the kind of rapid psuedo-growth (housing market) that we had come to depend on. If this oil price contribution to slower economic growth was indeed significant, then one could make the case that this current financial scenario is an early warning shot about the effect of peak oil on global economic stability.
As oil lurchs upwards once demand picks back up, fragile economies will suffer mightly. This will again whittle away at demand, atleast temporarily. And thus we will see a very rocky path for oil prices, likely overshooting on both the upside and downside.
In effect, perhaps this all points to fact that we have reached peak oil- that is peak 'affordable' oil. The global economy may not be able to spend enough money on oil to produce and consume more than 86 million barrels a day, even if we have not reached the geologic peak.
Jim, do you think this makes sense? I still think the price will escalate even with blunted demand, if only due to a gradually eroding dollar.

2008 Sep 29 11:11 AM

[Alex Filonov:]

Oil is going down from here. Yesterday was a good illustration, because traders got a feel of Great Depression II. No commodity goes up in worldwide depression, ever. Oil is not an exception.
The fact that Ike affected production, that it put offline more than 20 platforms in the Gulf, was reported, but wasn't widely commented. I don't understand why.

2008 Sep 30 12:55 PM

[chistletoe:]

yes, demand is down.
Its the latest repeat-ad-nauseum-and-... just in case someone was making too much noise eating potato chips and did not hear it, from our beloved media.

When, oh when, will you also report that production is down? Not just because of two hurricanes, but permanently? Forever? And its still getting worse?

Before the hurricanes, the USA production had declined another 2% for the year, or over 40% from its all time high.

Meanwhile Pemex reports that their production has now slipped another notch, now under 50% from its high five years ago.
Norway reports that its production has also slipped, to 60% of its all-time high several years ago.
Nigeria you should know about already.

And while everyone listens assiduously to every word coming out of the Saudi and other OPEC oil ministers' mouths, you seem to gently overlook what they are doing: actually reducing output and exports.

Oil is never, never going to get cheaper.
even in constant US dollars.
And as usual, you are so busy cleaning up the last mess that
you are not anticipating the next one, inevitable though it is ...

2008 Sep 28 02:57 PM